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How Crypto’s Meltdown Changed the Regulatory Debate

Cables connect to a cryptocurrency mining rig at the HydroMiner GmbH cryptocurrency mining facility near Waidhofen an der Ybbs, Austria, on Friday, Jan. 19, 2018. HydroMiner, the Austrian cryptocurrency miner that mines bitcoins with green energy, is weighing an initial public offering to fund an expansion outside its home country. Photographer: Akos Stiller/Bloomberg (Bloomberg)

It’s harder to argue that your parents should leave you alone when you’ve just smashed up the car. As digital assets lost more than $2 trillion in value and a string of prominent ventures blew up in 2022, most notably the FTX exchange, the debate over cryptocurrency regulation shifted sharply. The turmoil also heightened the stakes in a battle that had already been brewing in Congress over which of the nation’s top market regulators, the Securities and Exchange Commission or the Commodity Futures Trading Commission, should take the lead on crypto oversight. Separately, the SEC has made clear that it considers most digital assets to be securities, a designation that brings with it an extensive set of requirements, while the top US banking regulators issued a sweeping statement on the dangers of crypto.

1. How did the debate change? 

The collapse of FTX and the charges of criminal fraud filed against its co-founder, Sam Bankman-Fried, led to widespread embarrassment in Congress and among regulators. He and several other top FTX executives had donated heavily to the campaigns of Democrats and Republicans and taken a leading role in an effort to craft a new regulatory regime that reflected the priorities of some in the crypto community. While regulators pointed to the fact that crypto’s woes had not destabilized traditional financial markets, they faced criticism for not having taken actions to head off the industry’s worst abuses.

2. What had crypto leaders been pushing for? 

Crypto executives and financial titans like Citadel Securities had joined a 2022 industry push for a Senate bill that would have given the CFTC, the US watchdog on futures and derivatives trading, more power to regulate crypto assets. Currently, the CFTC primarily oversees crypto futures. The biggest crypto trading platforms argued that the assets they list should be considered commodities — that is, items whose values rise and fall separate from the profitability of the venture producing them. Even after the fall of FTX, CFTC Chairman Rostin Benham said its implosion was an example of why his agency needs more power to oversee cryptocurrency trading.

3. What’s the case for the SEC?

Many opponents of the Senate bill said that the SEC’s rules offer more protections for small investors. The SEC was formed in the wake of the market crash of 1929 and sees its core mission as protecting investors by requiring copious disclosures by financial entities. SEC Chairman Gary Gensler, a former head of the CFTC, has responded to criticisms that traditional regulations don’t match the realities of cryptocurrency by saying the agency could waive some of its rules to better suit digital assets, while also ensuring investors are protected, if exchanges work with the agency to register.

4. What has the SEC been doing? 

It’s been making clear it thinks many digital assets look like the kinds of investor-funded ventures that are considered securities and so fall under its rulebook. Anxieties among crypto traders rose when the SEC took the unusual step in an insider trading case in mid-2022 of identifying nine crypto assets that it considered to be securities.

5. What does it mean for something to be a security?

For the SEC, the question is whether something resembles a stock sold by a company to raise money. Specifically, the SEC asks whether a venture involves an investment of money in an enterprise whose profits will come from the efforts of others — a four-pronged assessment known as the Howey test, from a 1946 Supreme Court ruling. For instance, in 2020 the agency sued Ripple Labs Inc., claiming that the company was funding its growth by issuing the XRP digital tokens to investors who were betting that its value would rise. If a token is designated as a security, those creating it are subject to the same raft of rules that govern initial public offerings in the stock market, such as registration and reporting requirements. For crypto exchanges, the designation means they can’t offer for public sale any token that doesn’t meet those requirements, as well as imposing strict investor-protection requirements for platforms.

6. What coins are or aren’t considered securities?

There’s a lot of ambiguity on that question. US regulators agree that Bitcoin, by far the largest digital asset, isn’t a security. It was started by an unknown person or persons going by the pseudonym Satoshi Nakamoto and does not exist as a way to raise money for a specific project. In 2018, Ether, the second-biggest token, was also deemed not to be a security: While the Ethereum Foundation initially issued Ether to raise money, it had grown into something sufficiently decentralized that it probably wasn’t a security, a senior SEC official said — a position Gensler has declined to endorse. And when Ethereum switched in September to a new system for recording transactions that depends on coins being pooled or “staked,” Gensler asked whether the interest offered on such deposits could make staked coins a security.

7. What did the banking regulators say? 

The US’s top banking regulators — the Federal Reserve, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency — on Jan. 3 issued a joint statement raising concerns about the risks posed by digital assets, such as scams, legal uncertainties around custody and misleading statements from crypto firms. In a warning to lenders, they said it’s important that risks that can’t be controlled aren’t allowed to migrate to the banking system.

8. Is this an issue elsewhere?

Yes. Rules adopted by the European Union that have not yet come into effect will seek to regulate tokens that reference another type of asset or act like a digital version of fiat money, like stablecoins. The UK’s Financial Conduct Authority also regulates digital assets it considers investments that come with rights to repayment or a share in profits. But “payment tokens” like Bitcoin, or “utility tokens” that provide access to a service, remain unregulated in both regions. Singapore regulates both types but under different laws. It considers coins that are digital representations of other assets, such as unlisted shares, to be securities provided they are offered by an approved exchange. In 2022, the Monetary Authority of Singapore announced proposals to tighten access of crypto trading to retail customers after the crash in the digital token market. In Brazil, a new law was enacted in December that created the country’s first framework for cryptocurrency, with ground rules for brokerages that offer crypto as well as the assets’ day-to-day use. Brazil’s Congress acted after the FTX collapse increased interest in putting regulations in place. 

• A Treasury Department report on issues related to crypto regulation.

• A look at the crypto industry’s push in Washington to avoid securities regulation.

• Gary Gensler’s first interview on crypto after taking over as SEC chair with Bloomberg Businessweek.

• A BGOV OnPoint of cryptocurrency legislation being considered by Congress.

• A Bloomberg QuickTake from 2018 shows how long these fights have been going on for.

• The executive order on crypto regulation signed by Biden.

• An article on the SEC’s fight with Ripple.

• The UK FCA’s breakdown of regulated versus unregulated tokens.

--With assistance from Ben Bain.

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